The economic impact of the COVID-19 pandemic has been grave and unprecedented. Global economic output has nosedived, sending crude oil prices into a tailspin. The question a few weeks ago was not whether oil prices may keep on falling but how low will oil prices plunge. Not a few speculated prices within the lower band of $10 per barrel. Though, prices have rallied temporarily, it is nowhere near the pre-COVID levels. It is still early days yet to determine the movement of price, especially movement towards the northern direction and many analysts have opined that the production cut may not be enough to offset the drop in demand. In other words, we are in for a long haul.
As such, an attempt to speculate on the likelihood of a pre-COVID 19 price recovery in 2020 may be considered preposterous against the backdrop of the subsisting battle with the pandemic. Even normal times, the art and science of forecasting crude oil prices is an arduous task. Nonetheless, this write-up takes a look at the geopolitics of oil, key policy issues and events in the United States that may shape the direction of crude oil prices in 2020, post-COVID 19. To this end, the analysis examines the likely movement of prices within the context of US energy security, unemployment, the forthcoming presidential election, the interest of US allies in some of the oil producing countries and economic competitiveness with China.
But before we go into all that, let us start with a bit of context. For most of the oil producing countries in dire financial straits triggered by the steep drop in oil prices, stemmed by the ravaging global pandemic, the only way to shore up public revenue was through increased volumes of crude oil into a market that was already too soft. The resulting scramble for market-share and oversupply went further to exacerbate the downward price spiral until Saudi Arabia and Russia (the second and third largest oil producing countries in the world with combined output of 23 million barrels per day or 23 percent of global oil production in 2019), agreed to an output cut in order to prop up oil prices. The jury is still out whether the output cut can sustain and shore up price.
President Trump played a key role in the crude oil production curtailment pact. The interesting thing is why US involvement in an initiative that is somewhat not in consonance with its status as the foremost oil consuming country in the world with a share of 20.5 percent of global consumption (or 20.5 million barrels per day in 2019 including NGL), given the country’s vast industrial base and what low crude oil prices mean to the US economy in terms of lower production cost, low inflation and higher economic growth.
Is such intervention not against the principle of free market economy but the reality is that market can and has always been tamed if it becomes too wild and exuberant – a subject for another day. Now here is the spin – President Trump’s role in brokering a truce was not such of a moral dilemma, it was a well-informed decision that is based on enlightened self-interest.
The United States is not just the foremost oil consumer in the world, the country is equally the leading oil producer with average daily production of 19.33 million barrels in 2019 (including Natural Gas Liquids). What this means from a self-sufficiency standpoint is that the country has a supply-demand net imbalance of just 1 million barrels per day which can easily be met through imports from neigbouring countries. Being a high cost producer, oil prices below production cost will be particularly devasting for shale players. Many shale producers are currently on the brink of bankruptcy. Anything that is likely to upset that supply-demand balance would force supply security to the top of the policy agenda in the United States.
Bearing in mind that about 63 percent (7.7 million barrels per day) of oil produced (crude oil and NGL) in the US in 2019 was from tight shale formations (according to US Energy Information Administration), significant production cutback will widen the supply-demand gap and make US susceptible to supply vulnerabilities. Can the inventory build in US Strategic Petroleum Reserve (SPR) provide short term cushion? The answer is in the affirmative. However, the SPR capacity of 713 million barrels has a depletion timeframe of about 6 months depending on frequency and quantity of withdrawal. Moreover, the objective is not to completely drawdown on SPR but to release inventory during severe supply interruptions.
Some analysts were of the view, even before Trump’s intervention, that in an election year, domestic producers in the US, especially in swing states would require some level of support in whatever shape or form. The devastating effect of the economic downturn is not only having a heavy toll on the fiscal position of oil producing regions in the United States, both Washington and the states would also have to contend with the political implication of massive job loss, in an election year. Added to this is the likely implication of sustained low crude oil prices on efforts to diversify to alternative sources of energy.
From a geopolitical standpoint, US allies in some of the oil producing countries require oil revenue for political stability and if it is therefore thought that a low oil price regime could endanger the government of such countries and by extension the interest of the United States, it then raises a major foreign policy concern for US government. Viewed from another perspective, low prices for imported oil by China against high cost of domestic oil in the US enhances the former’s economic competitiveness. How the US will react to this is up for debate.
On a final note, oil prices are determined by drivers which impact demand and supply. Much more, oil prices are a product of consensus, not only of demand and supply but also by the behaviour of those who make the price.
Oil is a strategic commodity which sits delicately within the global geopolitical and geo-economic vortex and geopolitics is not an easy fit into economic models. As I told a former boss a few days ago, just as war is too important to be left in the hands of generals, crude oil is too important to be left in the hands of oil men and bankers.
Economic outlook is highly uncertain, and recovery may be gradual but as the global production engine rev up and aircrafts take up the sky once more, post COVID-19, further production cut is not unlikely. Therefore, global oil price recovery within the $50 per barrel corridor before the end of the year, perhaps much earlier, will hardly be a surprise. Don’t ask me if this outlook is from a crystal ball if you think Liverpool FC will not be handed the English Premiership this year. That will be cruel!
Glenn Ubohmhe
Glenn Ubohmhe (FCA, FCTI) lives in Lagos
